Big Picture Favors Big Stocks

1/31/2011


Our strategy is premised on finding opportunities one stock at a time, using our Quadrix® rating system to uncover attractively valued growers. But we also take note of big-picture considerations, especially the market's primary trend under the Dow Theory. When both the Dow Industrials and Dow Transports confirm an uptrend by reaching significant highs, as they did this month, we're more inclined to view a pullback as a buying opportunity. As a partial hedge, our buy lists have 12% to 15% in a short-term bond fund.

We also like to see confirmation from industry-group or sector peers when evaluating individual stocks. If most of the companies in a group are delivering strong results, we're less likely to be fooled by a company enjoying an unusual, unsustainable growth spurt. If most stocks in a group are seeing profit estimates and share prices move higher, we're less likely to be fooled by noisy data or false share-price breakouts. And if most of the stocks in a group are cheap, it often means that investors are truly pessimistic about the industry's growth prospects — not simply penalizing a single name.

Today, Quadrix scores provide clear-cut direction on three crucial big-picture considerations:

Large stocks are more attractive than small stocks. The median stock in the S&P 1500 index of large, midcap, and small stocks trades at a trailing price/earnings ratio of 18.5, slightly above the norm of 18 since 1994. But the median is 17 for the S&P 500 index of large stocks, below the norm of 18. And the 50 largest companies in the S&P 500 have a median P/E of 16 — well below the norm of 21. Relative to the broad market, the top 50 stocks have seldom been cheaper over the past 16 years. Large stocks also earn higher Quadrix scores for Momentum. As a result, the median Overall score is 72 for the largest 50 stocks, versus 60 for S&P 1500 stocks.

Among sectors, Quadrix favors technology. About 38% of S&P 1500 technology stocks earn Quadrix Overall scores above 80, versus 31% for the second-best sector, health care.

Among industry groups, only three earn average Overall scores above 80. In the managed-care group, we prefer smaller, government-oriented providers like Metropolitan Health Networks ($5; MDF), HealthSpring ($30; HS), Magellan Health Services ($49; MGLN), and Amerigroup ($49; AGP). All four are recommendations of our sister newsletter, Upside.

In the high-scoring life and health insurance group, Aflac ($58; AFL) represents our top pick based on its solid operating momentum and modest valuation.

Quadrix scores have jumped sharply for the integrated oil and gas group. Our top picks in the group are Hess ($77; HES) and Exxon Mobil ($79; XOM).


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